Financial System of USA 1492 1860 English

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The financial system of the Colonies and United States

(1490-1860)

1.Economy and finance in America upon the Arrival of Columbus

Whatever their origin, there were at least 1.5 million human beings living in the

Americas when Columbus arrived. They spoke over 200 languages that were as

complex and rich as any language spoken anywhere in the world. There were

no written languages, no printing presses, and very little use of money or other

medium of exchange. Although some ancient tribes appear to have used crude

forms of currency, little of those economies remained in North America at the

time of Columbus. Trading among the Indian tribes was not well developed, but

did exist.

Barter or simple sharing was the chief method of trade among the Indians.

The economies of the Indian tribes differed by region, but included agriculture,

hunting, and fishing, all with varying degrees of sophistication. Buffalo, deer,

bear, and other game were hunted for their meat, hides, and fat. Communal

hunts were conducted in order to kill large amounts of game. Fertilizer was in

use, tobacco was cultivated, sunflower seeds were sown, acorns gathered, and

salmon were being caught long before Columbus arrived. Corn and squash were

being grown in the Southwest United States by Indian tribes as long as 6,000

years ago. Although tools were limited in America, at least some tribes were

engaged in metal working. Absent was a device that had greatly increased

agricultural production in Europethe iron plow. There were also no Indians on

horseback, as caricatured by the movies, because no Indians had horses until

Columbus and his followers introduced them into the Americas after 1492.

Another form of transportation was missing as wellthere were no wheels to

facilitate travel.

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When the European financiers learned of Columbuss voyage, the New

Worlds fate was sealed. The Europeans lust for gold, wealth, and adventure

was an irresistible lure that would focus the energy of Europe. Efforts to exploit

the New World began almost immediately after Columbuss discovery. Two

hundred tons of gold and 18,000 tons of silver were brought from the Americas

to Spain between 1521 and 1660. After Columbus arrived, it took the Spaniards

only about fifty years to loot Central America of most of its gold. Although the

Spaniards and their conquistadors made explorations into what is now the

United States, they did not remain. By 1562, there was not a single white man in

what is now the United States.

2.The English in North America

Englands interest in America began to awaken with the voyages of Sir

Francis Drake and the slave trader John Hawkins in the latter part of the

sixteenth century. Drakes seizure of Spanish ships and the wealth beingreturned to Europe by the Spanish explorers was of particular interest to Queen

Elizabeth I. She had a financial stake in at least one of Drakes voyages. Queen

Elizabeth sought to encourage further exploitation of the New World in 1578 by

granting a patent to Sir Humphrey Gilbert for discoveries in America. The

patent allowed Sir Humphrey to settle and explore any part of the New World

not already claimed by a Christian prince. Although he was allowed to claimsuch discoveries for himself and his heirs, Sir Humphrey did not live to enjoy

the benefits of owning what is now the richest nation in the world.

The mechanism that would organize the English explorations was the

joint-stock company, which had appeared in England by 1553, a scant sixty

years after Columbus returned from his voyage to America. A joint-stock

company generally allowed each investor one vote in company matters,

regardless of the size of their investment. There was no limited liability for

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shareholders in joint-stock companies. Shares could be transferred, and the

company was managed by elected officers. A joint-stock company, once

formed, usually raised additional capital by making calls on existing

shareholders.

The most significant role was played by the Virginia, Plymouth and The

Dutch West India Companies. Authorized by its charter to settle the south

Atlantic coast of America, the Virginia Company financed the expedition that

created the Jamestown colony. There were about fifty merchant company

investors, and it had an equally large governing council. Shares in the Virginia

Company were sold to adventurers. The adventurers were those who stayed

at home and risked their money in the venture. The individuals who went to

America for the London Company were called planters. To encourage

emigration, every planter was to be given one share of the company, which the

company was to bear expenses and receive any trading income. Planters were

given parcels of land for every tenant they transported to the colonies. Those

tenants were often indentured servants who were promised land and profits inexchange for their services. Subsidiaries of the Virginia Company were formed

for a number of purposes, including the transporting of young women to

Virginia for marriage partners. Of course, since this was a commercial venture,

the new husbands were required to pay for the passage of their future wives.

The Dutch West India Company was chartered in 1621. Five years later

the company made its most famous deal, often cited as the steal of the

millennium. For a load of cloth, beads, hatchets and seeds then worth only $24

the Manhattan Island was purchased from the Indians. On the island a new town

called New Amsterdam was founded, which in 1674 will be renamed by the

English to its present name New York.

The Dutch settlers also gave America its most prominent financial symbol

Wall Street. Sometime around 1653, the Dutch Settlers built a twelve-foot-

high wooden stockade fence in lower Manhattan in order to protect themselves

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from attacks by the British, the Indians, and other unwanted guests. In 1685,

Wall Street was laid along the line of the fence of the Dutch stockade.

3.Regulation of Trade

The colonies were viewed by England and its merchants as a source of

wealth to be exploited for their benefit. This meant that commerce in the

colonies had to be regulated strictly to assure that any riches found their way to

England. The Crown, for example, reserved the largest and tallest trees in

America for British ships. Equally important was the need to prevent the

colonies from competing with English merchants. England, therefore, ordained

in 1630 that the American colonies could not make woolen, linen, or cotton

cloth. In addition, only plantations owned by the English merchants were

allowed to export produce. Colonists owning farms could produce only for

domestic consumption. The corn laws closed the English ports to cereals and

meats imported from the colonies, and heavy duties were placed on whale oil.The Wool Act of 1699 prohibited exportation of wool from the American

colonies. A report to the Board of Trade in England around 1715 stated that

goods valued at about 1 million English pounds were being brought to England

from the plantations in America. Goods valued at over 700,000 were being sold

to the colonies annually. About two-thirds of English shipping was engaged in

this trade, and this commerce supported about 200,000 persons in England. In1726, a Mr. Bladen sent a short essay to Lord Townshend that listed the benefits

of the colonies to England. Among other things, Bladen noted that the colonies

consumed one-sixth of the wool manufactured in England, double that amount

of linen and calico, and great amounts of silk, furniture, and trinkets.

4.Money in America

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Missing on the arrival of the immigrants to America was any functioning

currency. The early settlers were able to create a crude form of money by using

beads and trinkets in their trade with the Indians, as did Columbus. An

excavation of the original fort at Jamestown in 1996 yielded dozens of sky-blue

glass beads apparently manufactured by the colony for trade with the Indians.

John Smith got himself out of hot spots by trading these beads. Such beads

would remain a favorite currency for trading with the Indians for at least two

more centuries. The value of the beads varied with their color. As Meriwether

Lewis noted in preparing for his famous expedition across the country in 1803,

blue beads are far more valued than the white beads of the same manufacturer

and answer all the purposes of money. Cash in the form of specie (i.e., gold or

silver bullion and coins) was in short supply in the colonies. Mining rights to

gold and silver were granted to the Virginia and Plymouth settlers under their

royal charters. The Crown was to receive one-fifth of all gold and silver that was

mined. But those rights proved to be of little value because quantities of gold

and silver were not among the riches of the Atlantic coast. The lack of gold andsilver meant that the authority given to the Virginia Companys resident council

to coin money was worthless. Specie would have to be imported or a substitute

found until the western gold discoveries just before the Civil War. This

sometimes required imagination. In Quebec, the French intendant had to use

playing cards as notes for provisioning troops. The cards were later redeemed

from the annual appropriation that came by ship from France in the form of

specie or bills of exchange. The English colonies were equally imaginative.

Nails were scarce, for example, and sometimes used as a currency. Wampum

strings of purple and white beads made from shells that were sewn together into

beltsbecame a currency in the trading areas of the Plymouth Company and

was exchanged for furs with the Indians. In 1643, the Massachusetts court ruled

that wampum was acceptable currency for the payment of debts up to forty

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shillings. White wampum was valued at eight to a penny and black wampum at

four for a penny.

6.Commodity Money

Tobacco was an accepted medium of exchange in the southern colonies.

Quit rents and fines were payable in tobacco. Individuals missing church were

fined a pound of tobacco. In 1618, the governor of Virginia issued an order that

directed that all goods should be sold at an advance of twenty-five percent, and

tobacco taken in payment at three shillings per pound, and not more or less, on

the penalty of three years servitude to the Colony. Virginians were even

purchasing wives from England in 1620 with tobacco. A joint stock company

for transporting 100 maids to be made wives was formed for this trade. The

maids cost twelve pounds for their passage and were sold at the rate of 150 lbs.

of tobacco. Young men in Virginia were said to have showed up with tobacco

under their arms to greet and pay for their new wives. A later writer notes,however, that it would be difficult for one person to carry all of the tobacco

required for full payment. He suggests that what the would-be husbands were

carrying was only enough tobacco to provide earnest money, thus in fact

buying his wife on margin.

7.Coins as Currency

The English government discouraged most efforts to bring specie to

America. The imbalance of payments with the colonies assured there would be

few breaches of those restrictions. As Benjamin Franklin later noted, much of

the specie that did find its way to America was quickly withdrawn as a result of

the unfavorable balance of trade with England.

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Making change was a problem because of the shortage of coins. The

difficulty in making change in the Colonies had led to the extensive practice of

dividing gold coins with a chisel. Virginia prohibited the cutting of gold coins

into lesser pieces to make change in 1727.

Virginia established the Spanish dollar, valued at six shillings, as the

currency of that colony in 1645. The Spanish piece of eight would become the

basis for the United States dollar. The current dollar sign is said to reflect the

figure eight, and the two lines in the dollar sign are found on the reverse side of

the old Spanish dollars. The word dollar is actually a derivation of the name of

a German coin, the thaler. Thalers were produced beginning in 1519 in a small

Czech village that later came under German control. The U.S. dollar is also

sometimes referred to as a buck. This too traces its origin to the Spanish

dollar. There was a large trade in deerskins in the colonies. A buck was the

standard of the trade, and by 1750 the term already had become a synonym in

the American colonies for its monetary equivalent, the widely circulating

Spanish dollar.Even though they depended on foreign coins for most of their specie

transactions, the American colonies used the silver standard that had been

established in England in setting monetary values. Monetary calculation in the

colonies was further based on the English system of pounds, shillings, and

pence. Under that system, twelve pence equaled a shilling and twenty shillings

equaled a pound.

8.Financing Independence

America had no army, other than mostly untrained militia, and there was

no financial system to finance a war with the most powerful nation in the world.

There was no central government, no national treasury or exchequer, and there

was but little support for taxes to finance the revolt. The American states were in

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want of two of the most essential matters which governments could be destitute

ofmoney and credit.Since the Revolution was based on resistance to taxation,

and because the revolting states had no foreign credit, the colonies were left

collectively and individually to the printing presses to provide the currency

necessary to conduct war. This was indeed paper money.The first issuance of

Continental money was authorized on May 10, 1775.They authorized the bearer

to receive Spanish milled dollars or the value thereof in gold and silver. This

statement was less than truthful. The Continental Congress did not have the

wherewithal to pay specie to redeem the currency. The Continental bills ranged

in denominations from one to twenty Spanish dollars.

The Continental money maintained its value on a par with gold and silver for a

time, but that happy situation soon changed. The value of the Continental dollar

rose and fell with the fortunes of the American army, and then plummeted as the

colonies exhausted their credit.At one point, seventy dollars in paper was not

equal to one dollar in silver. During a three-week period in May of 1779, prices

increased by 100 percent.The Continental dollar plunged until it was worth lessthan a copper penny. By 1781, it cost more to print a Continental dollar than it

was worth as currency. The ultimate depreciation of the Continental bills

resulted in the phrase not worth a Continental, a measure of worthlessness that

survives today.Yet, even in the face of the massive depreciation in their value,

historians have asserted that the Revolutionary War would not have been won

by the United States without the issuance of its paper money.

9. Robert Morris

A bright spot in Continental governments finance was the emergence of

Robert Morris as the man responsible for the countrys finances. The position of

Superintendent of Finance was created in 1781 to oversee the finances of the

fledgling government. Morris, a Philadelphia merchant, was appointed to fill

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that position. He was referred to in that role as the Financier. Morris accepted

the position only on the condition that Congress would allow him to continue his

private commercial concerns and connections. Morris risked his personal fortune

to support the Revolution. He was said to have raised $1.5 million for the army

by issuing his own personal notes. By placing his personal credit behind the

government, Morris was able to stabilize a financial situation that had nearly

brought the government and war effort to a standstill. Morris issued notes for the

government that he guaranteed personally, as well as in his capacity as

Superintendent of Finance. These notes became known as Bobs because of

Morriss signature. There were Long Bobs and Short Bobs that were

identified as such by their maturity date. Morris was able to obtain the services

of a partnership of merchants, Comfort Sands & Co., to supply the Continental

Army on credit. He was able to pay for supplies by borrowing funds from

private merchants, including Haym Salomon, who loaned $211,000 to the

government and purchased bills of credit totaling $353,000 that provided funds

desperately needed to pay the Continental Army.Morris sought to establish a central bank through the Bank of North

America, which he controlled. That bank then became, roughly, the

predecessor to our Federal Reserve System.The Bank of North America began

its functions as the nations bank in January of 1782, and received the privilege

from the government of its notes being receivable in all duties and taxes to all

governments, at par with specie. In addition, no other banks were to be

permitted to operate in the country. In return for its monopoly license to issue

paper money, the bank would graciously lend most of its newly created money

to the federal government to purchase public debt and be reimbursed by the

hapless taxpayer. The Bank of North America was made the depository for all

congressional funds. The first central bank in America rapidly loaned $1.2

million to the Congress, headed also by Robert Morris.After a year of operation,

however, Morris, his political power slipping after the end of the war, moved

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quickly to end his banks role as a central bank and to shift it to the status of a

private commercial bank chartered by the state of Pennsylvania. By the end of

1783, all of the federal governments stock in the Bank of North America, which

had the previous year amounted to five-eighths of its capital, had been sold by

Morris into private hands, and all U.S. government debt to the bank had been

repaid. The first experiment with a central bank in the United States had ended.

10. Alexander Hamilton and laying the foundations of the United States

financial system

The Revolution freed the colonies from the economic tyranny of England.

That was cause for celebration. More than a little daunting was the fact that the

new nation lacked any coherent financial system. Economic problems were

immediate. Much of the mountain of debt issued by the former colonies and the

Continental Congress to fund the Revolution was still outstanding and in arrears.

The debt of the Continental Congress alone was well over $200 million, and thatof the former colonies was even greater. In truth, no one knew the exact amount

of the debt because there were so many locally issued bills and certificates.

To solve the serious financial problems was appointed, the first Secretary

of the Treasure, the 32 years old Alexander Hamilton. Hamilton laid the

foundations of the young states financial system with his specially designed

financial plan, containing several key elements.

10.1 Foreign Debts

The first element called for paying off in full the loans that foreign

governments had made to the Continental Congress during the Revolution. In

1790 the principal on these loans amounted to roughly $10 million. The United

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States owed two-thirds of these debts to France, one-third to the Netherlands,

and a small amount to Spain. No one in Congress or the administration

challenged Hamilton's arguments that the United States had a legal and moral

obligation to pay off these debts, and that it had to do so in order to establish the

credit of the United States, and its citizens, in European financial markets.

10.2 Domestic Debts

The second element was more controversial. This was Hamilton's

proposal for repaying the debts that the Continental Congress and the

Confederation government had incurred by borrowing domesticallythat is,

from individuals and American state governments. These debts, amounting to

about $42.4 million, had resulted from the selling of bonds to supporters of the

Revolution and the issuing of various notes to pay soldiers and farmers and

merchants who had supplied the revolutionary armies. This proposal consistedof two parts. Hamilton believed that the two parts of the plan would work

together. The plan would create a class of wealthy citizens who, because they

were long-term creditors of the new national government, would be loyal to it

and take an active interest in its affairs. As a consequence, the central

government would be strong and able to finance wars or fund major national

projects. In addition, the permanent debt, because its owners could readily

convert it into money or other assets, would provide capital to meet the needs of

an expanding economy.

Members of Congress generally agreed with Hamilton that the new

federal government had a legal obligation to pay the domestic debts that the

Confederation government had incurred. Article VI of the Constitution provides

that "All Debts contracted before the Adoption of this Constitution, shall be as

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valid against the United States under this Constitution, as under the

Confederation." But many in Congress, including James Madison, argued that

the federal government ought to negotiate down the domestic debts and take into

account the interests of those who had first owned the securities. Critics pointed

out that the inflation of the war years and the depressed conditions of the 1780s

had forced many of the original owners, including revolutionary war soldiers, to

sell them at substantial losses. The speculators, including wealthy American

merchants, Dutch investors, and even British investors, who had bought these

deeply discounted notes, stood to reap huge windfall gains under Hamilton's

redemption program.

10.3 Debts of the States

The third element of Hamilton's policies was the proposal that the federal

government take over the $25 million in debt that the state governments had

accumulated during the Revolution. With this "assumption" program, Hamiltonsought to strengthen further the nation's financial reputation, to bolster the

nation's stock of capital, and to enhance the financial power of the federal

government. All of the states had debts from the war, but their efforts to pay off

the debts had varied greatly. Massachusetts and South Carolina had been

sluggish in paying off their war debts and had much to gain from assumption.

Four southern statesGeorgia, North Carolina, Virginia, and Marylandhad

been aggressive in paying off their debts. For them, assumption threatened to be

costly, requiring them to subsidize the plan through new federal taxes.

10.4 The Bank of the United States

In December 1790, Hamilton also proposed the fifth element in his

financial plan: the federal chartering and funding of a powerful institutiona

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national bank, which would be called the Bank of the United States and modeled

to some extent on the Bank of England. The bank was to be a commercial bank,

which was a rare institution in America. State governments had chartered only

four of them. The Bank of the United States, in Hamilton's view, would be very

different from the other commercial banks. One difference would be its sheer

size. Hamilton proposed capitalization for the bank that would make it five

times the size of all the other commercial banks combined. This meant that the

bank could expand significantly the size of the nation's money supply and thus

enhance economic activity.

In February 1791, Congress passed a bill that adopted most of Hamilton's

specific ideas for the new bank. Congress provided for a twenty-year charter, a

pledge that the government would not charter another bank during that period, a

capitalization of $10 million, 20 percent ownership by the federal government, a

requirement that 75 percent of the stock subscribed by private parties be

purchased with United States securities, and a provision for locating the

headquarters of the bank in Philadelphia.

10.5 The Mint

In January 1791, while the Bank of the United States was still under

debate, Hamilton submitted the "Report on the Establishment of a Mint." The

creation of a mint, the sixth element of his economic program, followed the call

of the Constitution for a national coinage. Hamilton's goal was to create a

system of coinage that would be uniform across the United States and provide

monetary stability. Uniformity and stability would promote commerce, enhance

the credit worthiness of the United States, and protect the value of tax revenues.

Hamilton personally preferred gold coinage but he recognized the political

reality that many members of Congress worried about the shortage of gold and

the potential deflationary impact of a gold standard. Hamilton proposed, instead,

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a bimetallic standard based on the minting of both gold and silver coins. Both

gold and silver coins would be legal tender, and the mint would buy gold or

silver at an official ratio of fifteen ounces of silver to one ounce of gold. The

most common coin in circulation was the Spanish silver dollar, and it had

provided the unit with which the new nation valued its debts. To ease the

transition, Hamilton recommended adopting the dollar as the basic unit for the

coinage of the new republic, and keeping the silver content of the new dollar

close to that of the Spanish one. In addition, to facilitate small transactions, he

recommended an elaborate fractional coinage. Congress adopted almost all of

Hamilton's proposals in the Coinage Act of 1792.

The Coinage Act established a bimetallic dollar standard for the United

States. The dollar was defined as both a weight of 371.25 grains (24 ) of

pure silver and/or a weight of 24.75 grains (1.6 ) of pure golda fixed

ratio of 15 grains of silver to 1 grain of gold. Anyone could bring gold and silver

bullion to the mint to be coined and silver and gold coins were both to be legal

tender at this fixed ratio of 15-to-1. The basic silver coin was to be the silverdollar, and the basic gold coin the $10 eagle, containing 247.5 grains (16 )

of pure gold. The 15-to-1 fixed bimetallic ratio almost precisely corresponded to

the market gold/silver ratio of the early 1790s, but of course the tragedy of any

bimetallic standard is that the fixed mint ratio must always come a cropper

against inevitably changing market ratios, and that Greshams Law will then

come inexorably into effect. Thus, Hamiltons express desire to keep both

metals in circulation in order to increase the supply of money was doomed to

failure. Unfortunately for the bimetallic goal, the 1780s saw the beginning of a

steady decline in the ratio of the market values of silver to gold, largely due to

the massive increases over the next three decades of silver production from the

mines of Mexico. The result was that the market ratio fell to 15.5-to-1 by the

1790s, and after 1805 fell to approximately 15.75-to-1. The latter figure was

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enough of a gap between the market and mint ratios to set Greshams Law1 into

operation so that by 1810 gold coins began to disappear from the United States

and silver coins began to flood in. The fixed government ratio now significantly

overvalued silver and undervalued gold, so it paid people to bring in silver to

exchange for gold, melt the gold coins into bullion and ship it abroad. From

1810 until 1834, only silver coin, domestic and foreign, circulated in the United

States.

1Greshams law is observation in economics that bad money drives out

good money. More exactly, if coins containing metal of different value have

the same value as legal tender ( ), the coins

composed of the cheaper metal will be used for payment, while those made of

more expensive metal will be hoarded or exported and thus tend to disappear

from circulation. Sir Thomas Gresham, financial agent of Queen Elizabeth I,

was not the first to recognize this monetary principle, but his elucidation of it in

1558 prompted the economist H.D. Macleod to suggest the term Greshams law

in the 19th century.

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Financial System of USA 1492 1860 English

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